The Bank of Israel keeps the interest rate for July 2010 unchanged at 1.5 percent

28.06.2010
 
The Bank of Israel keeps the interest rate for July 2010 unchanged at 1.5 percent
 
The Bank of Israel announces that the interest rate for June 2010 will remain unchanged at 1.5 percent.
Background conditions
Inflation data: The CPI for May rose by 0.4 percent, within the range predicted by forecasters, which was between 0.2 percent and 0.5 percent. The housing index continued to rise relatively rapidly, by 0.7 percent, and by 1.6 percent since the beginning of the year. Inflation in the last twelve months was 3 percent––the upper limit of the target inflation range––and adjusting for the effects of changes in indirect taxes and surcharges, it was 2.7 percent. Since the beginning of the year prices have risen by 0.4 percent––below the middle of the seasonal path consistent with an annual inflation rate of 2 percent for 2010.
Inflation and interest rate forecasts:On average, forecasters expect the rate of inflation over the next twelve months (June 2010 to May 2011) to be 2.6 percent. Inflation expectations derived from the capital market rose after the publication of the May CPI, and in the last week they varied around the upper limit of the inflation target. In the next three months the forecasters, on average, expect a cumulative increase of 1 percent in the CPI (seasonally adjusted, this increase is consistent with the lower half of the target inflation range), and of 1.9 percent in 2010 as a whole. According to these assessments, the inflation rate, measured over the past twelve months, will continue to decline towards the midpoint of the target range. With regard to the Bank of Israel interest rate expected for a year hence, expectations calculated from the capital market are for an interest rate of 2.4 percent, while forecasters, on average, expect a rate of 3.0 percent. According to predictions based on assessments by the Bank of Israel's economists and model, inflation in the last twelve months is on a declining trend, and is expected to approach the lower limit of the inflation target at the end of the year, and its mid-point in another twelve months. Concurrently, according to the model, the Bank of Israel's key interest rate is expected to reach an average of 2.1 percent in 2010:IV.
Real economic activity: Indicators of economic activity that have become available during the past month, present a mixed picture, with some data suggesting a slowdown of growth. Assessments of continued expansion are supported by preliminary data from the Companies Survey for 2010:II and the GDP growth rate, which increased from 3.3 to 3.6 percent in the revised data for 2010:I. Additional support for this view was provided by the new reading of the growth in exports, in annual terms, in 2010 which was revised from 7.3 to 7.4 percent, as well as by the 4.8 percent rise in business-sector product in 2010:I. Assessments regarding the moderation of the rate of expansion are supported by monthly indicators of private consumption, which point to its continued increase, with some moderation in 2010:II (April-May data), by the Bank of Israel's composite state-of-the-economy index for April and May, which rose by 0.1 percent, and by gross VAT receipts on domestic production, whose rate of increase continued to moderate. In addition, data on export orders in the services and manufacturing sectors for 2010:III, from the Companies Survey, point to stagnation in exports. According to the Google Search Index, calculated by the Bank of Israel's Research Department, the probability of a moderation in demand continued to rise, and reached 80 percent. The sharp decline in the Purchasing Managers Index, as well as in the Globes newspaper's index of consumer confidence, also attest to the same trend.
The labor market and wages: Various indicators taken together suggest that there was a slowdown in the rate of recovery of the labor market in 2010:I. Data from the labor force survey for 2010:I indicate a further contraction in unemployment, for the third consecutive quarter, to 7.2 percent. However, the rate of decline was slower than in the previous two quarters, and was based on a fall in the participation rate rather than on a rise in employment. Real and nominal wages were up by 5.2 percent and 6.8 percent respectively, at annual rates, in the period January to March relative to the previous three months. In the same period the number of employee posts increased by 3.1 percent in annual terms.
Budget data: From the beginning of 2010 until May the domestic deficit was NIS 3.3 billion, compared with NIS 8.2 billion in the equivalent period in 2009. The deficit in this period was NIS 1.7 billion lower than that given by the seasonal path consistent with the budget, a deviation which stemmed primarily from revenues that were NIS 1.4 billion higher than in the budget forecast. Consequently, the deficit in 2010 is expected to be about 4 percent of GDP.
The foreign exchange market: From the previous monetary policy discussion, held on May 23, and until June 27, the shekel depreciated by 1.1 percent against the dollar, and appreciated by 0.4 percent against the euro, at a time when most currencies worldwide rallied markedly against both the dollar and the euro. In terms of the nominal effective exchange rate, the shekel weakened by about 1.2 percent, as a result also of its depreciation against the other currencies included in the currency basket against which the rate is calculated.
The capital and money markets:Between the monetary policy discussions of May 23 and June 27, the Tel Aviv 25 index dropped by 1.4 percent, and the Tel Aviv 100 index by 0.8 percent, despite the rise in the major stock markets around the world during that period. Yields on Israel government bonds declined this month along both the nominal and indexed yield curves, mainly in the short term. The yield gap between Israel and US unindexed 10-year government bonds narrowed this month, to stand at 147 b.p., as a result of sharper declines in yields in Israel. There was continued lively interest in Makam among foreign investors, but in May the extent of their accrual of Makam was significantly lower than in April. The Tel-Bond 20 index rose by about 2.2 percent over the period, and the Tel-Bond 40 index went up by about 1.8 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, dipped a little this month, in line with the trend in risk premiums around the world, and reached 115 b.p.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) fell by 0.2 percent in May, following its 2.2 percent increase in April; in the last twelve months it increased by 12.2 percent. The M2 aggregate (M1 plus unindexed deposits of up to one year) declined by 0.2 percent in May, following its 1.3 percent rise in April; in the last twelve months it increased by 4.2 percent.
The credit market: Total outstanding business sector credit rose in April by 0.7 percent, to NIS 740 billion, after declining by 0.5 percent in March. Of this, bank credit accounted for NIS 392 billion, up by 1.1 percent over March. Outstanding nonbank credit expanded by 0.2 percent in April, compared with a 2 percent decline in March.
The housing market: There was some moderation in the rise in housing prices in March 2009, according to the house price survey, and they were up by 21 percent over the past twelve months. Since the beginning of the year there has been a steady decline in the supply of new apartments for purchase, continuing the long-term trend. However, the number of building starts in the last twelve months is up by 6 percent over the preceding twelve-month period.
The global economy: The global recovery is continuing. In 2010:I growth accelerated against the backdrop of positive developments in inventories, the persistent positive effect of fiscal stimulus packages, and the ongoing monetary expansion. Some recovery was also evident in private demand. Nevertheless, the level of uncertainty regarding the persistence and extent of economic growth has increased, and it is generally expected that the growth rate will slow in the second half of 2010, mainly against the backdrop of the dissipation of the positive effects of government activity and the expected economic slowdown in Europe. In most countries the fiscal expansion is nearing its conclusion, and programs involving fiscal contraction have been introduced in Europe. Investors' apprehensions in view of the large debts and deficits of many countries, as well as of the stability of the banking system in Europe, have generated considerable uncertainty in the markets. Inflation and expected inflation remained moderate, primarily in the context of the continued weakness of the labor market and the high output gap. Thus, in view of the slowdown in Europe and indications of a loss of momentum in the US, combined with the low inflation rate, many central banks in the advanced economies are refraining from raising interest rates at present.
The main considerations behind the decision
The decision to keep the interest rate for June unchanged at 1.5 percent is consistent with the gradual process of returning the interest rate to a more 'normal' level, intended to position inflation firmly within the target range, and to contribute to the further recovery of economic activity, while supporting financial stability. The path of the interest rate will be determined in accordance with the inflation environment, the entrenchment of growth in Israel and globally, the rate at which the major central banks increase their interest rates, and in light of developments in the exchange rates of the shekel. At the current level of the interest rate, monetary policy continues to be expansionary.
  The trend of the inflation rate, measured over the past twelve months, has been downwards for several months. Since the beginning of the year inflation has been below the seasonal trend consistent with the middle of the target range for 2010. According to Bank of Israel assessments and forecasters' predictions, the retrospective twelve-month inflation rate will continue to decline to the middle of the range, or even below it, in the next few months. According to twelve-month forward inflation expectations, both of forecasters and those calculated from the capital market, in another year the inflation rate will return to the upper part of the inflation target range, with a cumulative interest-rate increase of between 1 and 1.5 percent in the next twelve months.
  After a period of a year of relatively rapid growth, some data have turned negative, leading to greater uncertainty about the persistence of this trend. Preliminary data from the Companies Survey for 2010:II show that economic activity continues to expand, albeit at a somewhat slower pace, with indications of weakness in exports for the next quarter, in both the manufacturing and the services sectors. The main negative indicators are: those for domestic activity­, export data and the Purchasing Managers Index; and for the global economy, developments in Europe and the US.
  The interest rates of the central banks of the leading advanced economies are very low, and in view of the increased concern over possible negative developments in the global economy and the continued moderation of inflation expectations, these interest rates are expected to remain low for significantly longer than originally anticipated. In addition, in light of recent developments, some of the unconventional instruments of monetary accommodation have been reintroduced.
Taking into account the increased uncertainties in the global economy, and in Europe in particular, and the effect these have on Israel's economy, the Governor has decided to leave the interest rate unchanged this month.
The Bank of Israel will continue to monitor Israeli and worldwide economic and financial developments, and will use the instruments available to it to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system.
The minutes of the discussions prior to the above interest rate decision will be published on July 7, 2010.
The decision regarding the interest rate for August 2010 will be published at 17:30 on Monday, July 26, 2010.